The Finance Act 2016 amended the provisions of section 206AA of the Income Tax Act, 1961 (‘Act’) with effect from 01.06.2016, thereby providing that the provisions of section 206AA would not apply to specified payments made to non-residents. The specified payments as provided under the amended provisions were introduced by the CBDT vide notification dated 24th June 2016.
It is to be understood that although the amended provisions of section 206AA are applicable with effect from 1st June 2016, the benefit would be available only from 24th June 2016 as the notification is effective from that date. An attempt is being made to unravel the notification and the resultant benefit available to the non-residents as well as to parties dealing with non-residents.
Before analysing the new notification, it is important to become aware of some of the related provisions under the act.
Section 195: Section deals with deduction of tax at source (TDS) on payments being made to non-residents. The rate of TDS specified is : (i) rate provided under the Act or (ii) Rate provided under the DTAA, as per the assessee’s circumspection. The obligation of deduction of tax at source arises only when the income being paid to non-resident is chargeable to tax in India.
Section 206AA: Section mandates tax to be deducted at a higher rate in absence of Permanent Account Number(‘PAN’) (Taxpayer Identification Number in India). The section comes into play only when some income is chargeable to tax in india i.e there exists an obligation to deduct tax at source.
Section 90:The section introduces Double Taxation Avoidance Agreements (‘DTAA’) under the provisions of the Act and provides that the provision of DTAA, if beneficial to the assessee, would override the domestic provision under the Act.
Having understood some of the related provisions,it is now appropriate to highlight the features of the much-awaited amendment. Notifications are issued by CBDT to either amend existing rules or introduce new rules. The CBDT vide notification No 56 of 2016 has introduced a new rule viz. Rule 37BC. Rule 37BC provides for specified payments being made to non-residents wherein the provision of section 206AA of the Act would not be applicable. The specified payments are (i) Interest,(ii) Royalty,(iii) Fees for technical services (FTS),(iv) Payments on transfer of any capital Asset. The applicability of above is subject to certain conditions as provided under the rule itself.
It is important to understand the cause due to which the notification was introduced in its very first place. Prior to the introduction of Rule 37BC, there was a controversy about the applicability of provisions of section 206AA to non-residents. As explained above, provisions of section 195 of the Act deal with the deduction of tax at source on payments being made to non-residents. In addition, provision of section 206AA of the Act deals with the aspect of deduction of tax at source wherein the recipient does not furnishes its PAN. Thus, the provisions of section 206AA technically overrule the specific provisions of section 195 dealing with TDS on payments being made to non-residents. The provision of section 195 gives an alternative for deduction of tax at the rate provided under DTAA or the rate provided under the Act. Similarly section 206AA provides the tax to be deducted at source at the highest of the three specified rates viz: (i) Rates provided under the Finance Act, (ii) Rates provided under DTAA or (iii) 20%. Thus if the rate of 20% is higher than the rate specified under the rate provided under DTAA, section 206AA warranted the deduction of tax at 20%. The issue created was due to the wordings of section 206AA, which contained a non obstante clause. This led to a controversy as to whether the benefit provided under section 90 would be lost in cases where provisions of section 206AA apply?
The judicial pronouncements have supported and taken the view that tax should be deducted at the rate provided under DTAA as against 20%. The underlying principle of the judicial pronouncements has been that section 206AA is merely a machinery provision which requires deduction of tax at source. Section 90 on the other hand, providing benefit of DTAA, is a beneficial provision that overrules the charging section (Section 4 and section 5) of the Act. Thus, when section 90 is superior to the charging section itself, the machinery provision cannot override the provisions of section 90. It was held that provisions of section 90 would overrule the provisions of section 206AA.
In the above context, reference needs to be made to Article 51C of the Constitution of India. The article imposes an obligation for fostering respect for international law and treaty obligations. Thus, there is a constitutional backing to the view that provisions of section 90 would override the non-obstante provisions of section 206AA.
A question therefore arises that after having favouring judicial precedents as well as backing from article 51C of The Constitution of India, why was a controversy still subsisting and accordingly why there arose a need to bring in the new notification?.This was necessary because the system used by income tax department for processing of TDS returns generated demands in case of non-residents not having PAN. This was irrespective of the fact that the non-resident is taking treaty benefit. Thus when the TDS returns were processed, there was an automatic demand generated in cases where tax was deducted as per DTAA rates. The taxpayers had to protest against such invalid demands, thereby making litigation inevitable. Also these were the cases covered under DTAA. There are instances wherein payments are made to non-residents and the domestic provisions under the Act would apply. These cases are not sheltered by the judicial pronouncements as they dealt with the issue of section 90 overriding provision of section 90. Thus, the deduction of tax at a higher adhoc rate as against the rate of tax created hindrance in the process of claiming credit of taxes.
In view of the above, the government therefore brought in the new rule. As explained above, the notification covers only specified payments mentioned therein. Thus payment of the specified nature would be free from the applicability of provisions of section 206AA, subject to the other conditions provided in the new rule.
One point, which is noteworthy, is that in the above list of specified nature of payments, Business Income is not included. Thus there arises an understanding that when the income is in the nature of Business Income for the recipient, the same is not covered by the new rule and accordingly provisions of section 206AA would continue to hound such payments. However, this contention is inappropriate. In case of business income the concept of permanent establishment comes into play. Generally, business profits are taxable only when they are attributable to a permanent establishment. Accordingly as a natural corollary, when business profits are not attributable to a permanent establishment, they would not be taxable. Once the payment are held to be not taxable, the concern of not being covered under the new rule is worthless as the provision of section 206AA would itself not apply. The new rule applies only on applicability of provisions of section 206AA and as explained above, provisions of section 206AA would get attracted only when there is an obligation to deduct tax at source i.e in case of payments being chargeable to tax in India. Considering a case wherein the profits are attributable to a permanent establishment and thereby being taxable, the worry of not inclusion of the same in the new rule is again meaningless. This is for the reason that, when a permanent establishment is in existence and has taxable income, it is obligatory for the permanent establishment to file return of income in India and pay taxes thereon. Once an obligation to file return of income is cry stallised, it is mandatory to obtain a PAN because a return of income or for that matter taxes cannot be paid in India without a valid PAN. Thus once a PAN is obtained the question of not being included in the new rule is of no relevance as again the provision of section 206AA would not apply. As explained above provision of section 206AA only apply to such cases wherein PAN is not furnished. This is based on a simple assumption that if a person posses a valid PAN the same would be furnished to the payer at the time of deduction of tax at source. Provisions of section 206AA get attracted only non-furnishing of PAN by the payee to the payer. If an entity inspite of having a PAN does not furnish it to the payer or the liability of filing return of income is disputed, still the non inclusion in the new rule should not be a cause of concern as the rate at which tax is to be deducted in such cases is surely more than the ad-hoc rate of 20% provided under section 206AA. The rate of tax would be more than 20%, both under the DTAA as well as under the domestic provisions. It is an established principle that when DTAA is silent on on a particular aspect, the corresponding provisions under the domestic law would be applicable.. Thus it can be observed that non-inclusion of Business income in the list of specified payments as provided under Rule 37BC has no impact either on payer or the recipient non-residents.
The only income, on reading the provisions of section 195 along with Rule 37BC, which appears to be affected by the exclusion from the specified list is dividend income. Under dividend income, also the impact of exclusion is not very significant. This for the reason that section 195 itself brings a carve out for non-deduction of tax at source if the dividend payment are covered under section 115O. This leaves a very small type of dividend payment arrangements, which would get affected by the exclusion from the new rule.
The rule provides certain procedural requirements to be fulfilled. These requirements are with respect to submission of details to the deductors. These details are: (i) name, e-mail id, contact number,(ii) address in the country of which the receiver is a resident.
In addition to the above requirement, the rule requires furnishing of the Tax Payers Identification Number (TIN) of the recipient to the payer. In absence of TIN any other unique identification number is to be provided through which the non-resident is identified by the government of that country.
The rule further requires furnishing of tax residency certificate to the payer. However the rule provides a leeway by stating that the tax residency certificate is to be provided only if the government of that country, of which the recipient is a resident, issues such certificate. Thus where the law of a country does not provide for issuance of tax residency certificate at all or does not provide for issuance of tax residency to a certain type of entity, then also the benefit of this new rule can be taken. Like certain countries do not provide tax residency certificates to fiscally transparent entities. These entities would still be able to take benefit of the new rule. However, if the law of a country provides for issuance of tax residency certificate subject to fulfillment of certain conditions and due to non-fulfilment of those conditions tax residency certificate is not issued, the benefit under the new rule cannot be taken.
The non-requirement of furnishing of Tax residency Certificate under the new rule should not be confused with the requirement of tax residency certificate under section 90(4). Provisions of section 90, as explained above, deal with DTAA. There is a pre-requisite condition established by the provisions of section 90(4) of possessing of tax residency certificate for claiming treaty benefits. This position of claiming treaty benefits remains unaffected. It is not mandatory that for every payment to non-resident, DTAA provisions have to be applied. While making payment to non-residents normal provisions under the act also apply. It is in regard to such payments that the new rules come to rescue.
This amendment is based on the recommendations of Easwar Committee, which has been setup for simplification of tax laws and reduction of litigation.
Thus by virtue of the new rule, the non-residents even if not claiming treaty benefits are saved from the rigours of the provision of section 206AA of the Act. This is a positive move from the tax authorities thereby giving positive signals to the global investors and trade partners. This is one of the many steps by the government to move towards a tax friendly and non-adversarial tax regime.
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